Why The Price Of Crude Oil Is Dropping

Oil continues to fall. Analysts and industry experts have their opinions about why. History, however, tells us that sometimes nobody really knows. Everyone is making his or her best educated guess but, in the end, it is all theory and difficult to quantify.

On Sept. 14, crude oil closed at a high of $98.94, leading market analysts to believe that it was poised to reach the $100 mark. At the time, economists, as well as Washington politicians in the midst of an election year, worried that higher prices would put a damper on economic growth as prices at the pump would continue to rise.

On that day, Reuters reported that rising crude prices were the result of actions in the currency market as well as reaction to the federal government's announcement of QE3.

Since that time, however, oil has retreated. As of Oct. 31, it was down to $86.23, a nearly 13% decline since the September highs. Why has oil dropped so dramatically in such a short period?

Superstorm SandySuperstorm Sandy made landfall on Monday, Oct. 29. From the Friday before landfall to the Friday after, the spot price of oil dropped just over 1%. Sandy has only served to place additional pressure on the commodity causing supply and distribution disruptions. While reports of two-hour waits for gasoline amid short supply flood the media, some analysts expected a sharp rise in both oil and gas prices.

Because two refineries in the northeast, responsible for processing more than 300,000 barrels of oil per day, are shut down, and others are operating at reduced capacity, the supply of oil was decreased. Demand, however, was affected more than supply. As repair to the infrastructure takes place and consumption returns to normal, prices should stabilize.

Technical CorrectionOil traders, anticipating intervention by the world's banks to stimulate economic growth, drove the price of oil up. As some anticipated, however, the euphoria has to end sometime. When traders realize that intervention has done little so far, they rethink their outlook. ITG Investment Research theorizes that the stimulus hope bubble burst, sending prices plummeting.

On Sept. 17, oil dropped more than $3 in less than a minute, leading some to describe the fall as something similar to a flash crash. Experts disagree about the reason such an irregular drop took place but some blame algorithmic trading for the fall. Other theories include a fat-fingered trader and pending expiration of the October contract.

Too Much SupplyWhen it comes to oil, not only is there too much supply, there is not enough demand. World economies are struggling. When the economy slows down, so does the demand for gasoline, diesel and jet fuel. People travel less, companies ship less and consumers curtail their driving habits to save money.

The Middle EastTension in the Middle East often takes the blame for oil market volatility. Rising tensions in the late summer months created fears of supply shortages, causing prices to rise. As those tensions proved to be mostly unfounded and the Middle East remained relatively quiet, traders may have covered their commodity hedges.

The Bottom LineTheories abound about why the oil market rises and falls. Energy traders know that commodities markets are volatile by nature. To look at a long-term chart of oil, investors find rises to $146 a barrel in 2008, which then fell sharply soon after. The oil market is a worldwide market and sometimes the cause of a rise or fall in price has no clear, discernible, single reason.